Today, the stock market is a hub where large sums of money flow between traders, investors, and stockbrokers. It is crucial to understand at least the basics of how the stock market works and how it can contribute to a sustainable world if one intends to be involved in it.
One of the many ways in which a company can raise capital is to sell its shares to public investors. It’s also a way for these investors to be stock owners of these publicly held companies and passively earn additional income. A stock market is exactly the place for these financial activities to happen; it can be a regulated physical or digital platform. The most famous stock exchange markets are the New York Stock Exchange (NYSE) and NASDAQ among others.
Let’s look at the players first. There are investors or buyers, traders or sellers, and stockbrokers. Buyers may include investment banks, institutional investors (e.g. mutual funds, pension funds), and individual private investors, while the sellers are usually understood to be the publicly-held companies whose shares are being exchanged in the market. Stockbrokers are intermediaries between the stock offering firms and potential investors and they buy, and sell stocks on behalf of their clients and may or may not be also advising them.
Investment banks come into play in special cases known as an initial public offering (IPO). An IPO is when a company decides to go public and offers its stocks for the first time. In this case, the company requests an investment bank to ‘back’ or ‘underwrite’ its initial stock shares in return for a payment. The bank conducts its due diligence, sometimes with the help of equity research analysts, in order to determine the value of the company and have an informed idea about the potential of that company to grow. It, then, handles the initial issuing of the stocks and guarantees a set price per share for its client. Most commonly, IPOs are purchased by big institutional investors.
The Working Mechanism
In short, the stock market enables participants to confidently exchange financial assets because it is a secure and regulated environment where operational risks are almost zero. You’ve already read about how the IPO process works when company stock is publicized for the first time. This process takes place in a primary market.
The secondary market, on the other hand, is the trading platform or stock market exchange where publicly-listed stocks can be sold and bought by everyone through a licensed stockbroker which is usually in form of an online trading platform or application such as Trading 212, eToro, Plus500 or XTB. A major difference with a primary market is that, in the secondary market, shares are transacted between investors, while in the primary market transaction happens directly between the investor and the stock issuer (company).
Exchange vs OTC Markets
So far, we have referred to exchanges when talking about stock markets. However, there is also a decentralized and unregulated secondary stock market where deal-makers are the main intermediaries instead of the exchange market itself. These are called Over the Counter (OTC) markets.
OTC markets do not have a physical location or specific exchange hours unlike the exchange and they operate through internet networks or phone calls. You can usually find small companies in OTC trading that do not meet the requirements to be listed in regulated exchange markets. Therefore, the level of transparency and stability is comparatively lower in OTCs than in trading exchanges where buyers and sellers have detailed information about the financial instruments they are trading. What is more, in exchange markets demand and supply forces determine the price of securities or different types of assets being exchanged? Conversely, in OTC markets, deal-makers or market-makers are the ones who quote prices.
How Can Stock Markets Contribute to Sustainable Development?
Over the last two decades, large corporations have been criticized for harming the environment or ignoring social issues in their supply chains. As a result, investors have pushed for environmental, social, and governance (ESG) transformations in businesses through their capital leverage and public campaigns. These dynamics led to many companies ‘going green’ and embracing ESG standards in their businesses (although greenwashing has been accompanying these initiatives all along).
Are ESG-friendly companies rewarded by the stock exchange market? Although research has shown that investment decisions considering ESG criteria achieve positive returns, not all the investors have sufficiently embraced the sustainability performance criteria in deciding on prospective investees.
That said there are explicit initiatives to establish a capacity in stock exchanges and market regulators to advance sustainable investments and promote company ESG performance. This includes, among others, Sustainable Stock Exchanges Initiative by United Nations Conference on Trade and Development (UNCTAD), UN Environment Programme Finance Initiative (UNEP-FI), UN Global Compact, and Principles for Responsible Investment (PRI). Stock markets facilitate a huge flow of financial assets which is key for the transition to sustainable development. Therefore, regulators should be actively integrating sustainability criteria into the working mechanism of stock markets, hence ‘bringing out the good’ inside businesses.
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